|
|
| What's Your Exit Strategy |  |  |  |
| Written by Chuck LeBeau | | Tuesday, January 27 2009 12:42 | Toomany investors have been advised that a policy of buy and holdis thebest way to invest for the long run. The advice is typically:“Just buya good stock and hold on as long as you can. The market willtake careof you.” Well, the stock market has not been taking care ofinvestorsfor quite a few years now. Instead, the market is takingstock investorson a wild stomach-churning ride—and there is no tellingwhere it willend. Investors are getting sick along the way and areunsure that therewill be anything left when the ride is over.
Buy and hold is failingas an exit strategy because it encourages await-and-hope outlook amonginvestors and does nothing to provide badlyneeded control of gains andlosses. Buy and hold may not be dead as anexit strategy, but if it’snot dead, it should be on its way to abetter life somewhere far fromthese volatile markets.
WHERE’S THE PLAN?The most obviousproblem with buy and hold is that it is not astrategy at all. It is, infact, the absence of any logical plan toprotect profits and limitlosses. A buy-and-hold approach sacrificesany semblance of control andrelies on luck and hope rather thanplanning and control.
Back whenthe stock market was less volatile, a buy-and-holdapproach was lessstressful, and the decision to buy and hold wasreinforced by a risingmarket that masked the fatal flaws that areinherent in the “sit tightand cross your fingers” school of investing.Record-high levels ofvolatility have clearly exposed the criticalflaws of holding in spiteof market conditions.
Buy-and-hold investors are now wishing theyhad followed betteradvice. The advice that they really needed to hearwas “Get your headout of the sand and take control of your exits!”
LOCK YOUR PROFITSLikemost simple sounding investment advice, taking control of exitsis mucheasier said than done. However, the rewards are well worth theeffort.Gains on winning stocks will be locked in, and losses on badinvestmentchoices will be limited. Investing will become a much morerewardingjourney, and investors will enjoy peace of mind along the way.
Unfortunately,investors never have as much control over theirinvestments as theymight like, so we must ensure that they strictlycontrol what is intheir power. For example, if an investor boughtshares of John Deere at$40 in 2006. It’s now early in 2008 and theshares have more thandoubled as they approach $100 (see Figure 1). Canhe or she control theprice of the shares and implement some strategythat will make theshares go to $120 for an even bigger gain? Obviouslynot.
 Investorshave absolutely no control over the upside price action.The investorhas to accept and protect whatever profits the marketgives him or her.
Ifthe stockholder is unable to control the size of the gains,what thencan he or she control? The downside. Although the investorcan nevermake the price go up from $80 to $120, he or she certainlycan make sureto not be holding Deere shares if they go down to $40 orless.
Now,one might oversimplify this issue of control and conclude thatinvestorscan control losses but that they have no control over gains.That’smostly true but, fortunately, not entirely. Even thoughstockholderscannot push prices higher, once the market has handed thema gain theycan make sure that it is not taken away or allowed to turninto a loss.Investors can and should carefully protect their profits.Here’s how.
TRAIL YOUR EXITS
A well-conceived plan of trailing exits should include effective logic for the exits and the discipline to implement the plan.
KNOW YOUR STOP POINTAcommon problem plaguing traders is a lack of discipline. Thereluctanceto sell stocks at a loss is a well-known problem forinvestors.Academics commonly refer to this reluctance as the“disposition effect”and many studies show that investors are much morewilling to exit astock at a profit than at a loss.
Overcoming the “dispositioneffect” requires planning, even beforethe stock is purchased. Thedecision process in buying a stock shouldalways include an analysis ofwhere the stock would be sold if it goesdown. Once the downside exitpoint has been determined, then the riskof the purchase can bequantified.
In general, the best policy is to give the initial exitplenty ofroom (more risk) but balance the increased risk by buying asmallernumber of shares (less risk). Using a wider initial exit pointwilltend to improve the percentage of winning trades at the costofenduring larger losses.
Research shows that cutting losses tooclosely can hurt overallperformance much more than the effect ofaccepting slightly largerlosses in order to increase the winningpercentage.
If the exit is planned in advance, it will be mucheasier toimplement and investors will not feel like they made a hastydecisionunder the pressure of a falling market. Also, having a plan tobuy thestock back if it changes direction to resume an uptrend ishelpful—andmakes the decision to exit on weakness much easier.
Nothingis wrong with selling a stock to protect capital and thenbuying backthe same stock if the price starts increasing again. Theknowledge thatthe exit may only be a temporary protective action canmake the decisionto sell more comfortable and improve an investor’sexit discipline.
Ifa stock runs away to the upside after an exit, the fault is innot beingprepared to buy it back, and it is a mistake to fault theexit inhindsight. The decision to sell to protect capital when a stockisfalling is always correct, regardless of the price action thatfollows.
POPULAR TRAILING EXITSMosttrailing exits are simple calculations, using previous lowpoints thattrail beneath the current price level. Here are a fewexamples ofpopular trailing exits:
1. A trailing dollar amount per share.
2. A trailing percentage of the share price.
3. A trailing moving average of the previous prices.
4. A trailing lowest low of the previous X number of days.
5. A trailing support level based on chart analysis.
THE PROBLEMThecritical flaw in these and many other exit strategies is thatthey failto adjust to changes in the volatility of the underlyingstock. Alltraders know that stocks go up and down and that much ofthis priceaction is absolutely meaningless. Market technicians oftenrefer tothese random price movements as “noise.” If investors settheir trailingexits too close, then they are likely to get kicked outof a positionfor no valid reason. Selling too soon and then seeing thestock resumeits uptrend is known as a whipsaw, and is one of the mainreasons that aprudent policy of trailing exits is abandoned.
Investors hate to bewhipsawed and would rather subject theircapital to severe loss than toexperience an occasional missedopportunity. However, missing asubstantial up move after an exit isnot the fault of the exit. The exithas the purpose of protectingagainst a significant loss, and the exitshould not be faulted fordoing its job.
If a substantial move uphappens to follow an exit, then any loss ofopportunity is the result offailing to implement a re-entry plan.
However, investors do not wantto exit unnecessarily, even if theyhave a logical re-entry plan inplace. To avoid unnecessary exits andthe dreaded whipsaw, they need tohave trailing exits that adjust tochanges in the volatility of theunderlying stock.
If the back-and-forth randomness in a stock is $2and investorstrail an exit at $1 below the price, then they will surelyexit simplybecause the exit is inside the current level of “noise.”Instead ofprotecting capital, they will be wasting it by exiting onrandom priceaction rather than exiting to avoid significant weaknessand thebeginning of a downtrend that is likely to continue.
Atrailing exit is most effective when it adapts to changes involatilityand moves closer or further away to remain just beyond thereach ofrandomness.
USE ATRRandomness can best be measured bycalculating a simple formula ofaverage true range (ATR), or investorscould use a more complicatedformula measuring standard deviations. Ihave found that keeping thingssimple usually produces the best results,so I recommend the averagetrue range (see Figure 2). ATR is the largestof:
1. Today’s high, minus today’s low.
2. Today’s high, minus yesterday’s close.
3. Today’s low, minus yesterday’s close.
 A LITTLE BACKGROUND
Averagetrue range was first introduced by J. Welles Wilder Jr.in his 1978 bookNew Concepts in Technical Trading Systems, and thisuseful measurementhas been enthusiastically embraced by markettechnicians. ATR is widelyused in a variety of trading applicationsand has proven to beparticularly helpful as a measurement ofvolatility applied to the taskof measuring randomness. ATR is afavorite tool for continuouslyadjusting trailing exits to avoid thecurrent level of randomness.
In2008 and throughout the modern era of stock market investing,increasinglevels of volatility have created a nightmare situation forinvestorsconcerned about risk. Buy-and-hold investors have sufferedthe most, butmore prudent investors using trailing exits have beenequallyfrustrated.
In the recent crashing market, any prudent exitstrategy has beenrewarded, and in this environment even setting simpletrailing exitsthat do not adjust for volatility would have avoided manycatastrophiclosses.
But exits that do not adjust for randomnesswill very likely proveto be a costly mistake in the volatile risingmarket that is mostlikely to follow the present decline. Highvolatility appears to behere to stay and nonadaptive exits will surelyresult in whipsaw afterwhipsaw as the market recovers in the future.
ATR IN ACTION However,if traders set their trailing exits in units of ATR, theycanparticipate in any market recovery without the fear ofgettingunnecessarily stopped out by exits that are much too close. Iftheaverage daily volatility is 20 percent or more (as it is now inasurprising number of stocks), it would not make sense to use atrailingexit of only 10 percent (see Figure 3).
 Thebest policy in these volatile conditions is to move the exitsoutsidethe randomness by at least two or three ATRs and trade a muchsmallerposition to balance the increased risk of the wider exits. Whenthemarket settles down and the volatility contracts, then an exitexpressedin units of ATR will move closer and reduce the level ofrisk. Once therisk is reduced, then position sizes can be expanded toa normal levelwithout the fear of abnormal losses (see Figure 4).
 PUTTING IT ALL TOGETHER
• Control what can be controlled. Investors cannot force prices to go up, but they can avoid riding prices down.
•Traders can and should control risk by implementing a strategyoftrailing exits that will avoid substantial and catastrophic losses.Buyand hold as we know it is dead. It was killed by extreme volatilityandunacceptable levels of risk.
• Any trailing exit strategy mustadapt to changes in volatility toavoid needless whipsaws. Average truerange is a valuable tool to makethe exits adaptive.
• If occasionalwhipsaws do occur, traders must have a strategy tore-enter the marketto avoid missing substantial profit opportunities.
• The currenthighly volatile market presents opportunity, but riskmust always belimited. Use trailing exits based on ATR and keeppositions small if theexits are wide. If volatility decreases, thenposition sizes can easilybe increased as exits move closer.
• Before investors purchase stocks, they must have a plan to exit and to re-enter if required.
• Traders have to muster the confidence and discipline to follow their plans.
Investors can take control of their investments for higher profitability, lower risk and some badly needed peace of mind.
ChuckLeBeau is the director of quantitative analytics atSmartStops.net. Hehas been investing for more than 40 years and is theco-author of Computer Analysis of the Futures Markets.He was abrokerage firm executive for more than 20 years and has managedboth ahedge fund and a commodity fund. He has lectured to thousandsofinvestors throughout the world and is best known as an authorityontechnical indicators, particularly as applied to exit strategies.
Originally published in the February 2009 issue of Stocks, Futures, and Options Magazine.
| | LAST_UPDATED2 |
|
|
狗仔卡
发表于 2009-2-3 04:42 PM
提升卡
置顶卡
沉默卡
喧嚣卡
变色卡
